On this quad-watching Friday, U.S. equity futures slide alongside Asian and European shares, after a torrid week full of political news and central bank developments, with Friday now anxiously eyeing the start of trade war between the US and China.

As reported overnight, it is now a done deal that President Trump will impose tariffs on $50BN of Chinese imports, with Chinese retaliation imminent. However, what hit S&P futures and sent the dollar sliding from 2018 highs was a subsequent report from Reuters that Trump is also preparing to release a second list for $100BN in Chinese tariffs which will target technologies Beijing hopes to be a leader in and which is expected to be enacted in about 60 days. In response, China's Foreign Ministry said that if the U.S. rolls out new tariffs, all previous bilateral agreements on trade will not come into effect; China will take “appropriate measures”. As a result markets are slowly starting to price in a messy collapse to all the ongoing trade negotiations between the US and China, which initially sent the dollar lower, but expect the move to be completely unwound once markets start scrambling for safe assets. Remember: full blown trade war is the best thing that can happen for the dollar.

Meanwhile, the European session caught between the ECB re-pricing in its dovish QE end, which sent the EUR lower, and tariff-related fears which in turn pushed the common currency higher and the USD/JPY through overnight Asian session low. The Stoxx 600 index fell 0.4%, led lower by the banking sector as Thursday’s signal from the ECB that interest rates will stay at historic lows through the summer of 2019 or longer was seen as a negative surprise for the sector’s profit recovery. The SX7P Stoxx bank sector index is down 2.1%, falling back toward a 1-1/2 year low hit in late May; sector is down 17% since year- high reached in January, and is the worst European sector YTD.

The European short-end continues to price out rate hike expectations while peripheral EGBs remain well-supported led by Italy as the dovish taper is seen as conducive for at least some more carry, until the market violently realizes that the party is almost over. Still, European core equity markets were well off the highest levels in reaction to the imminent launch of trade war.

The Euro suffered further drama just after 6am EDT when Germany's Hessischer Rundfunk radio reportedly said the CSU interior minister has announced the end of the CDU alliance in an internal message, however this was denied by a senior CSU lawmaker, but not before the EUR took a sharp dive lower.

Meanwhile, over in Asia, despite the PBOC's dovish decision not to follow the Fed's rate hike (risking another bur st of capital outflows), a 90BN yuan net liquidity injection and rumors that an RRR cut may be just around the corner, the Shanghai Composite Index fell to the lowest since September 2016, back toward the 3,000 level supported by the government's plunge-protection "national team" in the wake of Thursday's ugly economic data and as the U.S. prepared to release a list of Chinese goods that will face tariffs, while also putting together a 2nd round. As a result, the Shanghai Composite dropped as much as -1% at 3,014.before closing down 0.7% to 3,021.90, headed for fourth weekly loss, the longest downward run this year.

Also overnight, the BoJ kept its monetary policy unchanged as expected with NIRP held at -0.1% and 10yr JGB yield target at around 0%, while the decision was made by 8-1 vote with Kataoka the dovish dissenter again. While the BoJ maintained its assessment of Japan's economy which it stated is expanding moderately, the central bank cut its assessment on inflation and said that inflation expectations are proceeding sideways. The news sent the Yen sliding to session lows.

In macro trading, the dollar came under pressure as the abovementioned trade war concerns came back into the spotlight after President Donald Trump approved tariffs on Chinese goods worth about $50 billion and Reuters reported a second list twice the size was in the making. This helped the yen and the euro reverse early declines, with the euro rebounding from a two-week low of $1.1543 to a $1.1615 day high while keeping U.S. stock futures and emerging-market currencies under pressure. ECB aftermath also saw euro-area bonds trading in the green, with Treasuries following suit.

Despite the overnight setback to the USD, the greenback is still set for its best week since November 2016 as meetings of the Fed, ECB and BOJ highlighted the policy divergence in favor of the dollar. The yen bounced on haven demand after earlier slipping following the BOJ downgrading its inflation assessment, which intensified perceptions it’s in no hurry to exit its stimulus policy. Aussie and kiwi extended losses under weight of momentum selling by leveraged funds. After touching a two-week low of $1.3212, the pound reversed the drop to hit a new day high of $1.3292.

For at least a few hours, the bloodbath in Emerging Markets has halted although we expect it to resume shortly.

Euro-area government bonds rallied as traders pushed back bets for the timing of the ECB’s first interest-rate increase to December 2019, with Italy leading regional gains and the yield on bunds falling as much as 5bps; the yield on 10-year Treasuries fell 2bps to 2.92%

In other central bank news, ECB's hawk Ewald Nowotny said inflation is in line with the ECB's target, adds ECB is beginning normalization without setting off a taper tantrum, sees a trend toward USD appreciation. Over in Russia, the Russian Interest Rate Decision came in as expected at 7.25% vs. Exp. 7.25% (Prev. 7.25%) note, with analysts generally split between unchanged and a 25bps cut.

WTI crude is negative on the day as the week end approaches, with WTI -0.2% and Brent -0.7%, as investors look forward to further developments of the OPEC cut deal, OPEC’s meeting late next week, and rig counts later in the day. In the metals scope Gold is stagnant at ~USD 1300/oz. Steel has hit over 9 month highs as Chinese property data posted firm results, and is set to be in the green for the 3rd straight week. Copper is in the red for the second session in a row a growth concerns in China are rocking the metal.

Trump has approved tariffs on Chinese goods worth about $50 billion, said a person familiar with the decision, ratcheting up a confrontation with Beijing. The U.S. is also nearing completion of a second list of tariffs on products from China worth an additional $100 billion, which would be subject to the same public hearing process as the first, maybe taking 60 days or more, Reuters reported on Friday

Mario Draghi put the ECB on the road to raising rates, though he may never get the chance to complete the journey. Sixteen months before his crisis-marked tenure at the central bank draws to a close, he has shifted the ECB back toward using borrowing costs as the main policy tool

ECB’s Nowotny: inflation target has been achieved; full policy normalization will take significant time

German Chancellor Angela Merkel refused to back down in a clash over migration policy with her Bavarian allies, heightening the risk of a political crisis that could threaten her 13-year hold on power

Argentina’s central bank is getting a new chief after the monetary authority failed to stop the peso’s plunge despite obtaining the biggest loan in the history of the IMF

Senior European Union officials have informally discussed whether the U.K. might need to stay in the bloc past March 2019 if Brexit negotiations don’t accelerate over the summer.

Saudi Arabia is more confident than ever it can deliver the OPEC production increase that oil consumers have been demanding

Pro-European lawmakers in U.K. Prime Minister Theresa May’s Conservative Party are calling for new talks to reach a compromise on her key Brexit law, in an effort to avoid a potentially damaging showdown next week

U.S. economy is sprinting ahead of the rest of the world, at least for now. Spurred by solid consumer spending, the U.S. is increasingly likely to rack up growth of at least 4% in the current quarter

Asian equity markets were somewhat mixed as the region digested the fallout from the ECB, while participants also mulled over Trump’s decision to impose tariffs on China. ASX 200 (+1.3%) and Nikkei 225 (+0.5%) traded higher with Australia the outperformer on broad gains across all sectors. Elsewhere, Hang Seng (-0.4%) and Shanghai Comp. (-0.7%) were lower despite the PBoC conducting a net weekly injection of CNY 240bln and Pledged Supplementary Lending operation, as Trump’s decision to impose tariffs on USD 50bln of Chinese goods overshadowed the central bank’s liquidity efforts. Finally, price action in 10yr JGBs was uneventful throughout the morning amid gains in Japanese stocks and with participants side-lined prior to the BoJ conclusion, although JGBs later saw mild support on following the BoJ announcement in which the central bank kept policy unchanged but downgraded its assessment on inflation. PBoC injected CNY 50bln via 7-day reverse repos, JPY 30bln via 14-day reverse repos and CNY 20bln via 28-day reverse repos, for a net weekly injection of CNY 270bln vs. last week's CNY 300bln net drain. PBoC also announced a CNY 60.5bln Pledged Supplementary Lending facility operation. PBoC set CNY mid-point at 6.4306 (Prev. 6.3962).

Other Asian News

BOJ Keeps Policy Unchanged, Downgrades Assessment of Inflation

Emerging-Market Strains Deepen With Argentina in Tantrum

Shanghai Stocks Hit Lowest Since 2016 as Trump Tariff List Looms

Ritz-Carlton Crackdown Haunts Crown Prince’s New Saudi Arabia

European stocks are mixed in the wake of a rally driven by the ECB policy announcement in yesterday’s trade. The outperforming bourse is currently the CAC (+0.2%) with the IBEX (-0.8%) underperforming on the back of poor Spanish bank performance (Bankia -2.0%, Santander -1.8% and BBVA -1.3%). Lower yields are weighing on the baking sector as a whole, with the EU financial sector underperforming. The energy sector is seeing some pressure from lower oil prices. Rolls Royce (+10.0%) is leading gains as the co. affirmed FCF guidance for 2018, and outlined a mid-term ambition to deliver GBP 1 per share of FCF. Tesco (+2.2%) is also up on the back of positive earnings results and encouraging comments on the Bookers merger. H&M (-4.5%) reported uninspiring earnings and are negative for the day.

Other European News

European Banks Tumble as Hopes for Early Rate Hike Evaporate

Euro-Area Bonds Rally as Traders Push Back ECB Rate- Hike Bets

Steinhoff Sells Loss-Making Austrian Unit to Rene Benko’s Signa

Merkel Courts Government Crisis in Refugee Clash With Allies

In FX, the DXY hit fresh 2018 highs for the index around 95.140 before a retracement back below the 95.000 mark amidst latest US vs China tariff talk ahead of the anticipated announcement targeting an initial $50 bn goods. However, the Greenback is still firmly bid against the bulk of its rivals on further divergence in monetary policy following this week’s FOMC rate hike and shift to tighter guidance for H2 this year. Technically, DXY bulls will be eyeing 95.150 and then 95.470 assuming no major trend reversal and or deeper Usd pull-back. EUR - Extended post-ECB losses for the single currency and a concerted attack against barrier defences vs the Greenback at 1.1550, but only a minor breach and subsequent recovery to just over 1.1600. However, the Eur still looks heavy across the board in wake of Thursday’s dovish QE unwind from the ECB and rate guidance flagging a 6+ month gap between the end of asset purchases and first tightening move. For reference, 1.1510 is the ytd low and in terms of option expiries, 1.4 bn at the 1.1600 strike could be influential, but also 1 bn in Eur/Jpy at 127.50 as the cross straddles 128.00. No reaction to unrevised Eurozone inflation data or relatively hawkish comments from ECB’s Nowotny who also noted the Dollar’s stronger trend, but selling and buying in fast market conditions on reports about Germany’s CDU/CSU partnership ending were swiftly “rubbished”. AUD/NZD/CAD - All victims of the Usd rally to new ytd peaks as the Aud loses grip of another big figure to test support ahead of 0.7450, but actually holds up better than its NZ peer in a role-reversal with the Kiwi failing to stay above 0.7000 and down through 0.6950, and the Aud/Nzd cross bouncing off 1.0700. Meanwhile, the Loonie continues to languish post-G7 with the US-Canada row hardly conducive to resolving NAFTA issues, and Usd/Cad has climbed just over 1.3150 accordingly to expose 1.3165 chart resistance ahead of 1.3200.

In commodities, oil is negative on the day as the week end approaches, with WTI -0.2% and Brent -0.7%, as investors look forward to further developments of the OPEC cut deal, OPEC’s meeting late next week, and rig counts later in the day. In the metals scope Gold is stagnant at ~USD 1300/oz. Steel has hit over 9 month highs as Chinese property data posted firm results, and is set to be in the green for the 3rd straight week. Copper is in the red for the second session in a row a growth concerns in China are rocking the metal.

Looking at the day ahead, the final May CPI revisions for the Euro area will be made along with that for Italy. In the US we'll get June empire manufacturing, May industrial production and the preliminary June University of Michigan consumer sentiment survey. Elsewhere, the ECB’s Coeure will speak today.

Thanks for all the responses on who will win the World Cup from yesterday. In the sad absence of Paul the Octopus this will have to do. The order was as follows Brazil (24%), France (23%), Germany (14%), Spain (11%), Belgium / Argentina (both 7%), Iceland (4%), and with Switzerland, Portugal, Russia and Croatia also picking up a few votes. As you can see no-one voted for England. Interestingly I did the same exercise 4 years ago and back then Brazil (31%) pipped the eventual winners Germany (29%) as the EMR reader's favourites. Next came Holland (9%), Spain (7%), Argentina (6%), Belgium (4%), Italy (4%), France (3%), Uruguay (2%), with Greece, Ivory Coast, Russia, Cameroon, Switzerland and the US all below 1%. Again no votes for England. We obviously have long standing astuteness in the readership. Today’s big game is Portugal vs Spain which I’ll miss as I have my bi-annual night out alone with my wife. We have deliberately not been talking to each other all week so we hopefully have plenty to say to each other tonight.

A relaxing meal will be nice after ‘super week’ which although starting a bit slow has livened up over the last 36 hours. The combination of a hawkish Fed on Wednesday and a creatively dovish ECB yesterday has certainly increased activity although the extraordinary move from the ECB might depress volatility for a while until we get new news.

The fun and games started immediately with the statement with the big change being the inclusion of the reference “the Governing Council expects the key ECB interest rates to remain at their present levels at least through the summer of 2019 and in any case for as long as necessary to ensure that the evolution of inflation remains aligned with the current expectations of a sustained adjustment path”. The big shock was that inclusion of calendar based guidance on rates which is the first time the ECB has done such a thing and is a material evolution to the policy framework. The timing implies sometime between end Q2 and start Q3 depending on how you define “through the summer” however market pricing for a full 10bp hike had been closer to sometime just after midway through next year pre ECB with the June 2019 contract for example previously implying a 76% chance of a 10bp hike. Needless to say markets have pushed that back with June now at closer to 30%. Clearly the ECB can still push back this date if risks to the economy materialise but they’ve made it very tough to be hawkish for at least a year now.

I can’t help but feel a bit uncomfortable with this move though. When I was first taught economics - when the last century still had a fair bit of road left to travel - the school of thought at the time was that central banks should keep an element of surprise to their policy. However the ECB are increasingly at the other end of the spectrum. Indeed what happens if inflation edges up unexpectedly over the next 12-15 months. Do you simply say we’ve promised the market we won’t raise rates from the emergency negative yield levels or do you break your promises? If policy making was this easy you would permanently offer such guarantees. There is a reason you don’t. We’ll see if it ends up being a smart move or whether it backfires.

The other dovish element yesterday was the taper reference. It was no surprise to see the ECB announce a cut to €15bn/month from September (with QE ending in December) but the caveat was that it would still be “subject to incoming data confirming the Governing Council’s medium-term inflation outlook”. So this is was very much a conditional taper. Those were the two main developments. In his press conference Draghi confirmed that the ECB didn’t discuss when or if to raise rates but also that the decision on changes to forward guidance was unanimous which is notable given that this implies even the most hawkish members were on board. He was also asked if “through the summer” means September to which Draghi replied “if it had meant September we have said September” and that the choice of language was “intentionally not precise”.

Moving the focus to the corporate part of the ECB QE, Michal in our eam published the report “IG Strategy: Draghi Conjures up a Dovish QE/CSPP Taper” which summarises his latest views on what yesterday’s taper announcement means for corporate credit. It highlights that the ECB still has the option to allow reinvestments across QE programmes later in the year, which would enable it to rotate some maturing govies into corporate paper next year. If no such rotation takes place, the report shows there will be an abrupt fall in CSPP flows in January while PSPP flows would remain relatively material due to much greater redemptions. It also looks at the relative pricing of CSPP-eligible
and ineligible bonds. You can download the full report here.

There was also some interest in the ECB’s economic forecasts yesterday. 2018 growth was revised down three-tenths to 2.1% while 2019 and 2020 was left unchanged at 1.9% and 1.7% respectively. The big (hawkish) surprise was the 2018 and 2019 headline CPI forecasts which were revised up three-tenths to 1.7%. 2020 inflation was left at 1.7%.

As for markets well there’s no doubt that they reacted in a pretty dovish way. The Euro tumbled -1.89%, which is the largest decline since the Brexit vote on June 2016. Bond yields were lower everywhere you looked. 10y Bunds rallied 5.6bps to 0.424% (0.509% on the initial taper headlines). Similar maturity yields in France, Italy, Spain and Portugal were -7.7bps, -6.5bps, -5.9bps and -3.3bps lower respectively. 2y Bunds also fell 3.6bps. Treasuries also strengthened with 10y yields down 3.1bps and they are now 7.1bps off the intraday post-Fed highs.

Meanwhile equities turned on a dime just after the statement was announced. The Stoxx 600 rallied within a +2.17% intraday range before closing up the most since early April (+1.23%). The DAX ended +1.68% (most since 5th April), FTSE MIB +1.22% and IBEX +0.59%. Even the FTSE 100 closed +0.81% while last night the S&P 500 finished +0.25% while the Nasdaq rose to another fresh record high (+0.85%). It’s worth highlighting that while bond-sensitive sectors like utilities led the rally in Europe yesterday, European Banks didn’t really tumble as much as you might expect was the falling yields with the Stoxx Banks index down only -0.21%.

Moving onto trade tensions, WSJ reported overnight that President Trump has already approved higher tariffs on US$50bn worth of Chinese imports, with a final tariffs list on impacted goods to be released today. Conversely, the WSJ also cited unnamed Chinese officials who indicated that China will immediately retaliate with their own tariffs. Back in Europe yesterday, EU countries have unanimously backed a decision to impose import tariffs on US$3.3bn worth of US goods, with plans for it to be effective by early July. This morning, unnamed Mexican officials told Reuters that Mexico may impose higher tariffs on US$4bn worth of US corn and soybeans imports, although conceded this may be a final option as it would also hurt Mexico’s own agricultural industry. Our Chinese economists noted that if the trade war escalates meaningfully between US and China, China may: (1) tolerate the property and land market boom in tier 3 cities, (2) cut RRR twice in the rest of this year; (3) raise central government transfer to cities with worse economic performance.

Overnight in Asia, markets are trading broadly lower with the Hang Seng (-0.13%), Kospi (-0.55%) and Shanghai Comp. (-0.91%) all down while the Nikkei is up +0.39%. The BoJ has voted 8-1 to keep rates steady, but the bank did softened its view on core inflation. It now sees “consumer price growth in a range of 0.5% - 1%” versus its April statement which said “around 1%”. The Yen’s reaction was relatively muted this morning (-0.1%). We shall find out more in Governor Kuroda’s news conference after we go to print.

Back to yesterday. It’s hard to keep EM FX away from the headlines at the moment as yesterday it was the turn of the Argentine Peso to collapse -6.58% versus the dollar, marking another fresh record low. Bloomberg suggested it was press speculation about changes at the central bank which drove the move and even the Finance Ministry’s move to stabilize the fall with a $7.5bn intervention did little to help stem the bleeding. With the dollar rally and euro weakness EM FX in Eastern Europe also had a difficult time yesterday with the Hungarian Forint (-2.70%), Czech Koruna (-2.23x%), Polish Zloty (-2.06%) and Bulgarian Lev (-1.93%) among the other big fallers.

Meanwhile, WTI oil pared gains as Saudi Arabia’s oil minister said it’s “inevitable” that OPEC members will decide to boost supplies gradually when they meet in Vienna next week, although he added that “I think it’ll be a reasonable and moderate agreement” (+0.38% to $66.89/bbl). Elsewhere post talks with his Saudi Arabian counterpart, the Russian energy minister Mr Novak noted that “in principle” both nations supported a gradual rise in output, but “specifics will be discussed” next week.

Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the headline May retail sales jumped the most since November 2017 as consumers brought more motor vehicles and a range of other goods (0.8% mom vs. 0.4% expected). Core retail sales (ex-auto & gas) was also above market at 0.8% mom, with year to date growth up 5% yoy (vs. 3.9% previous), which puts the year on year pace at the highest since 2006. The weekly initial jobless claims fell to a c44.5 year low (218k vs. 223k expected), while continuing claims (1,697k vs. 1,732k expected) was also lower than expectations. Elsewhere, the April business inventories was in line at 0.3% mom. Following the above,the Atlanta Fed’s estimate of Q2 GDP growth was revised up 0.2ppt to 4.8% saar.

In Europe, the final reading of Germany and France’s May CPI was confirmed at 2.2% yoy and 2.3% yoy respectively, although the monthly rate for France was rounded up to 0.5% mom. Elsewhere, Sweden’s May CPI rose 0.2ppt mom to an in line print of 1.9% yoy. The UK’s May core retail sales was stronger than expected at 1.3% mom (vs. 0.3%) and 4.4% yoy (vs. 2.5% expected), in part due to favourable weather and the Royal Wedding. Meanwhile, the UK’s RICS housing survey was mixed, with slightly fewer respondents reporting prices declines over the past three months but a slightly greater proportion expecting price declines over the next three months.

Looking at the day ahead, the final May CPI revisions for the Euro area will be made along with that for Italy. In the US we'll get June empire manufacturing, May industrial production and the preliminary June University of Michigan consumer sentiment survey. Elsewhere, the ECB’s Coeure will speak today.